Strategic Outsourcing Decisions for Manufacturers that Produce Partially Substitutable Products in a Quantity‐Setting Duopoly Situation*

This article examines production and outsourcing decisions for two manufacturers that produce partially substitutable products and play a strategic game with quantity competition. When both manufacturers outsource key components to the same upstream supplier, their products become more substitutable due to the increased commonality of the products. In addition, outsourcing may create better consumer perception about the product if the manufacturers choose reputable suppliers with better brand or quality. We explicitly model the substitutability change and the brand/quality effect and provide conditions under which the manufacturers should outsource the components to a supplier. We present the subgame perfect Nash equilibriums for the situation in which there is only one supplier and the case in which two suppliers compete with each other in the upstream supply chain. Numerical examples are presented to illustrate the findings.